Not long ago, no-down payment loans were the height of fashion for homebuyers. But now that lenders have tightened their standards, borrowers once again are expected to "put some skin in the game," to use the industry's favorite catchphrase. That "skin" refers to the borrower's own cash, and it means down payments are definitely back in style.
The chief advantage of a down payment today is simply the ability to qualify for a loan, since only a handful of so-called "zero-down" loan programs still exist. Yet down payments have other benefits, too.
The more money you put down to buy a home, the smaller your monthly payments will be, explains Greg Gwizdz, national sales manager at Wells Fargo Home Mortgage in Des Moines, Iowa.
A buyer's down payment becomes a homeowner's instant equity when the purchase closes, and that equity can be borrowed against with a home equity loan or line of credit. Guidelines to qualify for these loans have become much stricter, however, and, Gwizdz adds, many first-time homeowners are "surprised by the true cost of owning and maintaining their home" and thus should keep some reserves rather than allocate every dollar to their down payment. Some loan programs require cash reserves for this very reason.
Benefits of a down payment:
Borrow less money to buy the same-priced home.
Shop among more lenders, loan originators and loan products.
Get a lower interest rate.
Pay less for mortgage insurance.
Avoid mortgage insurance altogether, if the down payment is at least 20 percent of the purchase price.
How to get a down payment
Many homebuyers have difficulty coming up with a down payment. Here are a dozen ways to do it:
12 ways to obtain a down payment:
Set up an automatic saving plan.
Get a gift from your parents, grandparents, other relatives or friends.
Sell a car, boat, motorcycle, collectibles or other assets.
Liquidate stocks, mutual funds, savings bonds or other investments.
Allocate your income tax refund.
Take a loan from your 401(k) retirement plan and repay yourself with interest.
Withdraw funds from your 401(k) plan, subject to taxes and penalties.
Collect on a loan that you made to someone else.
Get a bonus from your employer.
Explore homebuyer programs for public servants, if you qualify.
Apply for a state or local government homebuyer down payment program.
Use a private down-payment assistance program.
A down payment needs to be "sourced and seasoned," Gwizdz says. That means the lender needs to know how you obtained the funds and that you've had control of those funds for at least several months. Gifts and seller's concessions are acceptable, up to the percentage allowed by the loan program, but borrowed money can't be used as a down payment because it is debt that has to be repaid.
Government-Backed Programs Allow Smaller Down Payments
Two government-run programs are designed to aid homebuyers who haven't saved much for a down payment. The Federal Housing Administration, or FHA, offers mortgage insurance that allows qualified buyers to purchase a home with a 3-percent down payment, all of which may be a gift. The U.S. Department of Veterans Affairs offers a home-loan guarantee program that helps military veterans buy a home with no down payment.
Down-payment programs run by state and local housing authorities offer grants and low-interest deferred-payment loans to homebuyers, though the restrictions can be "pretty severe," says Ed Craine, CEO of Smith-Craine Finance, a mortgage company in San Francisco. Some programs require borrowers to live in a disadvantaged neighborhood. Others have income limitations, for example.
"The biggest problem tends to be that if you make enough money to qualify for a loan, you probably make too much money to get the down-payment assistance," Craine says.
Down-payment assistance programs offered by private organizations -- Nehemiah Corp. and AmeriDream are two of the largest -- convert money contributed by the seller into the buyer's down payment.
"They are using the seller's equity to fund a grant which allows the buyer to buy with no money down," says Peter Thompson, a senior loan officer with Professional Mortgage Partners in Downers Grove, Ill.
These programs "serve a need for people who struggle to save a down payment, if the seller is motivated to contribute," Gwizdz says. But these programs are not without controversy. The down payment is of value only if the homebuyer can afford the monthly payments, he says, and whether someone who didn't have the discipline to save a down payment would have that discipline to make the payments may be questionable.
Down Payment Or Closing Costs?
Should homebuyers who have limited funds allocate more money toward their down payment or set aside some share of the total for closing costs? The simple answer is that the down payment should be the first priority, up to at least 5 percent (or 3 percent for an FHA-insured loan) of the purchase price. Thompson explains why: "It doesn't matter if they have the money for closing costs if we can't show (the lender) that they have the money for the down payment."
If you've saved enough for a down payment, but not closing costs, here are some options.
How to get closing costs:
Ask the seller to pick up the tab.
Pay a higher interest rate in exchange for lender-paid closing costs.
Wait to buy a home until you've saved more money.
If you want the seller to pay the costs, you should discuss that concession upfront before you sign a purchase contract because payment of costs is a negotiable term that affects the seller's net proceeds from the transaction, Thompson explains.